Tuesday, July 6, 2010

No shortage of money

I first articulated this theme in September 2008, and have returned to it many times since. My point is that the recession of 2008-2009 was not caused by a Federal Reserve tightening of monetary policy, the way it's been with every post-war recession. The recent recession was caused by a massive increase in the demand for money, which the Federal Reserve then struggled to accommodate. Since the Fed finally caught on and pumped up bank reserves by a cool trillion, the economy has been awash in money. Banks may be still somewhat reluctant to lend, but borrowers have also been reluctant to borrow, on balance, and many people seem to want to actually reduce their borrowing (i.e., by deleveraging).

This chart shows that it takes more and more money to accommodate a growing economy and ongoing (albeit fairly low these days) inflation. The red line shows the annualized growth rate of M2 on a rolling three-month basis, and the blue bars show the annualized growth rate of nominal GDP on a quarterly basis. On average and over time, M2 tends to grow by about the same amount as nominal GDP. Over the most recent 3-mo. period ending June 21st, M2 grew at a 4.1% pace and shows signs of accelerating. I'm guessing we'll see nominal GDP growth of at least 3-4% in the second quarter, and if so that would be a sign that M2 velocity (GDP/M2) is roughly stable. I actually think that velocity is likely to increase a bit—it's been rising at a decent pace since last summer—and if so, then we could see nominal GDP come in at an even higher rate.

The dollar has weakened of late, and the growth of currency in circulation (a good proxy for he world's demand for dollars) has slowed down in the past few months, and those are both good signs that M2 velocity is rising (velocity being the inverse of money demand). So with M2 rising and M2 velocity likely rising as well, there is good reason to believe that we will be seeing healthy rates of GDP growth. Again, no sign here of any slowdown or imminent recession.


Public Library said...

"The recent recession was caused by a massive increase in the demand for money, which the Federal Reserve then struggled to accommodate."

I could easily say my arm was bitten off by an alligator but fail to mention I stuck my arm into his mouth trying to fish out the last dollar bill of the 50 I threw in there.

Sounds like from your point of view, if the result is the same then how you got there is of no consequence.

Additionally, where we are headed must be of no consequence either since as long as the Fed Provides the right level of money, everything should be alright.

That is, until the next Fed induced disaster that if they had any foresight, could have adjusted the quantity of money in advance to thwart off and problems.

You are exactly explaining the roller coaster ride we have all been on since the Fed took over the helm in 1913.

Bring on the gold standard and dismiss the bureaucrats and economists.

Benjamin Cole said...

Well, teh alrgest IPO in all hsitory is being brought to the gate---in China. A $23 billion monster for Ag. Bank of China.
In China, the money supply is expandingg at a 22 percent annual rate. They are avoiding a recession.

The Fed needs to blow the doors off. Low interest rates, as Milton Friedman concluded, are a sign of tight money. We have very low interest rates, and they will get lower.

When the latest CPI figs come out (July 19 or so, I think), I think we will see three straight months of falling CPI, the first time since the FDR days, or something like that.

I'll say it again: I would rather live through an an inflationary boom than a long recession/depression (think FDR).

Reflation of property values might be a prequisite to recovery.

Mr. Kowalski said...

Ah.. I've arrived at the "Paul Krugman for Imperator" site. Yes yes all is well.. just keep printing and borrowing and it'll all end well.

My opinion is decidedly different.. we as a nation will not see a recovery until the overall level of debt in the nation comes down to historic norms.. around 150% of GDP, versus the 375% of GDP we currently have.. and this does not include things like the promises made via Soc Sec and Medicare.

Here's my 2010 Predictions and the six month checkup:


Bye the bye.. you have a terrific blog and your insights are much appreciated, if different. I too have three kids and three grandkiddies and am very worried about the world they'll be inheriting.

Cabodog said...

Interesting to see the continued pessimism in the comments to your posts Scott.

Wondering how indicative the comments are to the overall sentiment of the market. Judging from where the S&P is, I'd say very indicative, including today when we come into the day bright and cheery and spend the entire session under pressure.

However, as you state, lots of indicators are pointing to a recovery. You haven't even discussed your "Dr. Copper" leading indicator yet, which is doing quite well and showing no signs either of a double-dip.

Gold seems to be on the retreat as well, indicating less fear in the marketplace.

Interesting news today regarding the future inflation in the price of Chinese goods/services; wondering how much that will affect the US economy a few years down the road.

John said...


One other gem:

That bastion of economic literacy the New York Times trotted out Robert Prector today to predict (according to some wiggly lines on a price chart) a 1000 dow in 'five or six years. Turns out its the most heavily emailed article of the day.

The crowd is decidedly bearish. Good time to go shopping.

Justin D. Tapp said...

Any thoughts about recent calls by Scott Sumner and other monetarists for the fed to pursue NGDP level targeting?

Scott Grannis said...

JDTapp: I'm not a fan of having the Fed target nominal GDP. It would be a very difficult task. The simpler the better, I say: let's have the Fed target price stability, or just plain old zero inflation. The economy will take care of itself, and if the Fed hits its target I would predict that GDP growth would be optimal. One big problem facing the Fed today is the Humphrey-Hawkins mandate to target low inflation and full-employment growth. It's theoretically impossible for the Fed to hit two targets with one policy tool (the funds rate). In practice its impossible as well.

Jeff said...

Scott: As I've said before, I've followed you and have tried to stay positive, especially with your comments on what you "look" at in terms of the market/economy fundamentals. To this point, you have stayed steadfast in your belief that the fundamentals of the economy do not justify the current market valuation....my question is..what would cause you to have some concern?

Benjamin Cole said...


You know, if you look at the chart, it appears the Fed had a more expansionist or accommodative money supply from 2001-2004 than now, despite this being a much deeper recession than the 2001-2 downer.

We didn't have much inflation after 2001-4, even with the monetary and fiscal stimulus of the Bush years.

Now, we are teetering on the edge of deflation, and perhaps emerging from the worst recession since FDR.

Why isn't the Fed more aggressive now, as they were in 2001-4? They even appear to spiked the money supply more after 9/11 than during the bank collapse days of 2008.

Scott Grannis said...

Benjamin: M2 growth is not always a sign of easy money; it is more often a sign of rising money demand which, if not offset by lower interest rates from the Fed, can result in an effective tightening of money.

McKibbinUSA said...

If money is so available, why is it that I am experiencing a sharp increase in offers from small to medium-sized business to deliver my services for equity rather than money...? Oh, the money shortage on main street is very real, which is often why businesses hire me to begin with. Money is in short supply right now on the street...

Rick said...

Scott, isn't the increase in the demand for money coupled with the corporate hoarding of cash consistent with deflation? Whether or not this causes another dip in GDP is irrelevant in a consumer spending driven GDP. If enough people cannot find jobs quickly enough, GDP will not grow at the rate necessary for a full recovery in time to avoid many baby boomers from demanding social security benefits early. In turn, that destroys even the most pessimistic actuarial assumptions.

Benjamin Cole said...

I am wondering how long until all the unemployed 55-65 year olds look at the their monthly health insurance bills ($800 for one person, and that's a base rate), look at how they will never get another job, and start to wonder if Obamacare is not the most wonderful idea ever.
The Fed simply has to kickstart this economy. This is not time for timidity.
I would rather live through a long inflationary boom than a long deflationbary recession. We are now flirting with the latter.

Charles said...

One wonders if M2 has any meaning at all in todays economy. What difference does it make if the fed buys a T-bill paying .15% and creates reserves in the banking system on which it pays .25%. It seems to me that - given the way the financial sector has evolved - the key monetary aggregate is the level of non-information sensitive debt. The evaporation of private sector AAA rated debt in the wake of the housing collapse was the essence of the financial collapse. This suggests the importance of numbers like M3 and quantitative easing programs.

Scott Grannis said...

Jeff: What would cause me to be concerned? I think it would have to be some unforeseen government action that threw a curve ball at the markets and the economy. A round of Smoot Hawley-like tariff wars, for example, that could shut down global trade. A big change in the laws governing the financial system, in which the law of unintended consequences could step in and turn what politicians thought was a sensible "solution" into a new nightmare. A big hike in corporate income taxes, which are already the highest in the developing world. A decision to impose capital controls, which might result in a sharp reduction in foreign investment. You get the idea...

Scott Grannis said...

WJMc: Money is abundant at the macro level, but as I've noted before and neglected to repeat here, it is not easy for small and medium sized businesses to get ahold of. The banking system, like many households and investors, is still shell-shocked and unwilling to take on risk as in normal times. The urge to deleverage and the desire to limit risk are still with us. The ratio of M2 to GDP is still quite high historically; people are sitting on money rather than spending it. I think this will improve with time and rising confidence.

It's a paradox, but today it's easier to borrow $1 billion than it is to borrow $10 million. The institutional (i.e., very large) segment of the financial world is healing much faster than the retail segment. That's unfortunate but probably not surprising. Improvement will likely "trickle down" with time.

Benjamin Cole said...

Seriously, if you look at the M@ supply, one would get the impression the Fed is fighting runaway inflation.

Benjamin Cole said...

More sniveling abut taxes and regs is not the proper right-wing response at this time.
Taxes and regs are much lower now than through most of our history, including the robust 1950-70 period (I can remember when stock market trading commissions were regulated--meaning most consumers had but three choices--passbook accounts, mutual funds or very expensive stock brokers. Believe me, things are a lot better today than the recent past).
We are suffering now not from taxes or regs (at least more than usual)but from too-tight money, and we need a bold round of qualitative easing. Now is not the time for timid half-measures, or the usual posturing and rants qued from radio-heads.

Paul said...

"We are suffering now not from taxes or regs (at least more than usual)but from too-tight money, and we need a bold round of qualitative easing.

We're suffering in large part from your boyfriend's war on the private sector. As Fareed Zakaria discovered: "Most of the business leaders I spoke to had voted for Barack Obama. They still admire him. Those who had met him thought he was unusually smart. But all think he is, at his core, anti-business. When I asked for specifics, they pointed to the fact that Obama has no business executives in his Cabinet, that he rarely consults with CEOs (except for photo ops), that he has almost no private-sector experience, that he's made clear he thinks government and nonprofit work are superior to the private sector. It all added up to a profound sense of distrust."

The risk takers are keeping their heads down low, hoping not to be noticed, not to be punished, by the socialist community organizer some people so mindlessly voted for President.

Benjamin Cole said...

I found both McCain's and Obama's lack of business experience to be deep negatives. McCain thought running a business meant getting a bigger outlay from the House/Senate Appropriations and Armed Services Committees.
Still, our problem now is too-tight money. We have had worse taxes and regs--I can remember Nixon imposing wage and price controls! How do your those apples.
Try to keep your commentary free of ad hominem slurs.

Paul said...

"McCain thought running a business meant getting a bigger outlay from the House/Senate Appropriations and Armed Services Committees."

Really? Any evidence at all to back that up? Because The National Taxpayer's Union and Citizen's Against Government Waste all score his record very favorably. Your boyfriend earned himself an F from both groups.

"Still, our problem now is too-tight money. We have had worse taxes and regs--I can remember Nixon imposing wage and price controls! How do your those apples."

Yeah, worked out fabulously, didn't it?

"Try to keep your commentary free of ad hominem slurs."

Oh, stop your left-wing sniveling.

Scott Grannis said...

Rick: strong money demand and corporate hoarding of cash could lead to deflation, but only if the Fed failed to accommodate the higher demand for money by supplying more bank reserves and/or lowering interest rates. I think it's clear that their provision of $1 trillion in reserves is sufficient. I see no monetary evidence of deflation, indeed all the evidence points to an excess supply of dollars: the dollar is weak, gold is soaring, and commodities are way up from where they were a few years ago, and the yield curve is quite steep.